The Effects of Foreign Shocks When Interest Rates are at Zero

35 Pages Posted: 17 Nov 2009

See all articles by Martin Bodenstein

Martin Bodenstein

Board of Governors of the Federal Reserve System

Christopher J. Erceg

Board of Governors of the Federal Reserve System

Luca Guerrieri

Federal Reserve Board - Trade and Financial Studies

Multiple version iconThere are 3 versions of this paper

Date Written: October 3, 2016

Abstract

In a two-country DSGE model, the effects of foreign demand shocks on the home country are greatly amplified if the home economy is constrained by the zero lower bound on policy interest rates. This result applies even to countries that are relatively closed to trade such as the United States. Departing from many of the existing closed-economy models, the duration of the liquidity trap is determined endogenously. Adverse foreign shocks can extend the duration of the trap, implying more contractionary effects for the home country. The home economy is more vulnerable to adverse foreign shocks if the neutral rate is low – consistent with “secular stagnation” – and trade openness is high.

Keywords: Zero lower bound, spillover effects, DSGE models

JEL Classification: F32, F41

Suggested Citation

Bodenstein, Martin and Erceg, Christopher J. and Guerrieri, Luca, The Effects of Foreign Shocks When Interest Rates are at Zero (October 3, 2016). FRB International Finance Discussion Paper No. 983r. Available at SSRN: https://ssrn.com/abstract=1507258 or http://dx.doi.org/10.2139/ssrn.1507258

Martin Bodenstein (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Christopher J. Erceg

Board of Governors of the Federal Reserve System ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States
202-452-2575 (Phone)
202-736-5638 (Fax)

Luca Guerrieri

Federal Reserve Board - Trade and Financial Studies ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States
202-452-2550 (Phone)

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